The S&P 500 finished the month of June last week, recording a gain of 0.48% with Friday's close at 2,718.37. The index traded up to a monthly high at 2,791.47 on June 13th and appeared poised to hurdle the fence at ~2,800, revisiting the scene of the downside reversal crimes that occurred at February's (~2,835) and March's high (~2,801). But this never occurred, unfortunately; it was if market participants pulled up to the fence at ~2,800, saw the boogeyman, and then decided to run away in the opposite direction. The S&P 500 proceeded to limp across the monthly finish line, and that's being kind. The index declined the final two trading weeks of June in extremely rare fashion - by recording consecutive calendar weeks that gapped down on Monday and spent the entire trading week below the prior Friday's close (i.e., two consecutive unfilled weekly gaps). This has only occurred twice since 1980, weeks ending 10/10/2008 and 02/12/1982.
The daily chart now sports a clear double top at the March and June closing highs, separated by a whopping 0.28 points. When paired with the clear double bottom across the February and April closing lows, separated by a whopping 0.88 points, we've got a closing price trading range between 2,581 and 2,786. Of course this falls "inside" our intraday price range that's defined by January's high at 2,872.87 and February's low at 2,532.69. The perpetual path to nowhere persists, for now.
So here we are, 97 trading days removed from a 10-day waterfall price decline from ~2,870 to ~2,532, and we haven't spent one tick either above ~2,870 or below ~2,532. If a singular "inside day" is indicative of indecision, or uncertainty, across the collective actions and behaviors of market participants, then a 97-day stretch that fits "inside" the preceding 10 trading days is indicative of a metric ton of uncertainty across the collective actions and behaviors of market participants.
I like to think of the price action for the S&P 500 as analogous to a boxing match between the bulls and bears, and it's through these lenses that I see 2018 akin to the Forrest Griffin and Stephan Bonnar fight from the Ultimate Fighter Season 1 finale. It was so entertaining, and so competitively balanced, that it was impossible to tell who was going to win the fight. Both fighters stood toe-to-toe and landed haymaker after haymaker, and that's what the S&P 500's price action resembles thus far in 2018. The bulls opened the year with a flurry of punches in bunches, staggering the bears. But the bears countered with a vicious combination, and it's been back and forth ever since. As soon as it appears the bulls have the upper hand (think the first half of June), the bears strike back (think the 2nd half of June), and vice versa. It's impossible to know who's going to win the fight at the moment; the winner will ultimately be crowned with a decisive breakout above ~2,872 or below ~2,532. A draw is always possible, with a draw defined as the remainder of 2018 staying confined between ~2,872 and ~2,532, but it's not probable. The punches being landed from each side are so heavy that someone's bound to go down, in my opinion. For now, I've enjoyed quantifying the punches being landed in an effort to get an idea of whose shots might have the more lasting impact.
The Bears Left Hook
The bears landed numerous left hooks the second half of June, helping to keep the price of the S&P 500 confined to February's range. This comeback secured the "4 Inside 5 Setup" I pondered in last month's post, with a "4 Inside 5 Setup" defined as each of the last four open-high-low-close (OHLC) bars fitting "inside" the bar from 5 months ago. This marks the 7th "4 Inside 5 Setup" since 1950, and while it's a crime of small numbers, it does draw a parallel to the year 2000. August of 2000 was the last time a "4 Inside 5 Setup" occurred and the bears went on to win the fight via a 9th round TKO. The S&P 500 declined -5.35% in September of 2000, and left August of 2000's close at 1,517.68 as "the top" for the next 78 months - the S&P 500 wouldn't close a calendar month above 1,517.68 until May of 2007.
The Bears Right Uppercut
The "4 Inside 5 Setup" solidified the second quarter (Q2) as an "inside quarter" for the S&P 500, that is the high from Q2 was below the high from Q1 and the low from Q2 was above the low from Q1. Q2 and "inside quarter" have been a volatile pairing with the most recent samples annotating a who's who of horrendous market climates (2008, 2001, 2000). Each of the last three samples where Q2 was an "inside quarter" saw the S&P 500 trade down by more than -22.84% at some point over the forward 12 months. Furthermore, following an "inside quarter" for Q2, the S&P 500 has declined in the month of July 6 instances in a row and 7 of 9 total. While this too is a crime of small numbers, it does draw another parallel to the year 2000 in terms of price action. If nothing more, this should help us all avoid complacency.
The Bulls Heavy Cross
Q2 went in the books as an "inside quarter", but it also went in the books as a perfect inside quarter as the S&P 500 closed higher for each of April, May, and June. While the bears fought out of the corner and were able to move the fight back to the center of the ring the second half of June, they still lost the round. Historically speaking, we have 15 prior calendar years since 1950 where the S&P 500 rose for April, May, and June. The index's forward 4-, 6-, and 12-month returns are damn near flawless, higher 14 of 15 samples for median returns of 5.17%, 10.32%, and 15.46%. All samples traded up by at least 8.90% from June's close over the forward 1 year, and again that's only the minimum drawup. The median drawup of all 15 prior instances records at 20.36% A minimum drawup of 8.90% at some point over the next year would target a trade up to ~2,959, and the median drawup would suggest an unfathomable ~3,271 at any time before June of 2019's close. Ironically, the measured move upside target from our trading range between ~2,872 and ~2,532 is ~3,212. From a drawdown perspective there has been virtually no pain forward-looking following the S&P 500 recording a 3-month winning streak over April, May, and June. 10 of 15 samples never closed a calendar month lower than June's close over the forward 1 year, and only 1 sample traded down -10% or worse from June's close at any time over the forward 1 year. This study lacks a sound premise as I don't have a rational explanation as to why the S&P 500 has behaved so positively following a perfect Q2, but there's hardly anything rational about the behavior of humans, especially those transacting in the equity markets.
The Bulls Stiff Jab
The chart of the Russell 2000 (RUT) doesn't look anything like the chart of the S&P 500, the RUT's already broken out. "Bullish" participants in the RUT's constituents have been peppering "bearish" participants with a strong stiff jab for most of the last four months. The RUT ended June on a 4-month winning streak. This brings about the old adage "strength begets strength" as the RUT's forward 6- and 12-month win-rate is fantastic following a 4-month winning streak, excluding overlapping samples. Of the prior 21 instances of a 4-month winning streak for the RUT, the index closed higher 6 months later 18 of 21 times for median returns of 6.09%. The index closed higher 12 months later 19 of 21 samples for median returns of 9.07%. All samples traded up by at least 4.97% from June's close over the forward 1 year, and once again that's the minimum drawup. The median drawup of all 21 prior instances records at 15.14% A minimum drawup of 4.97% at some point over the next year would target a trade up to ~1,724, and the median drawup would suggest an additionally unfathomable ~1,891 at any time before June of 2019's close. From a drawdown perspective, the RUT has shown volatility or a somewhat difficult path in producing these positive returns over the forward 6 and 12 months. 6 of the last 11 samples experienced a -10% correction from month-end signal date's close at some point over the forward 1 year. A -10% drawdown from June's close at 1,643.07 would place the RUT at 1,478.76, which would give back all of the RUT's recent breakout and leave the index back in the vicinity of its 2018 closing lows, which are presently 1,463.79 and 1,492.53.
Scoring The Fight
So through six rounds of 2018, the bulls are up 4-2 on the scorecard, but nobody would argue if you have it scored 3-3 (the bears could have easily stolen June). I find myself using the phrase "I don't know" far more often these days. It's not that I ever know where the S&P 500 is headed, it's that I usually have some conviction in choosing the likely winner of the fight, whether the bulls or the bears. At the moment, I have no idea who's going to win the fight. While my base case scenario for the S&P 500 is for a trade up above 3,000 over the next 3-4 months, followed by a sloppy finish to the year with 2018 closing higher by mid- single digits in percentage terms, my confidence in my base case is diminishing as each month passes.
As we look ahead to July, I'm once again left to question whether I'll be writing about a "5 Inside 6 Setup" next month, and it certainly appears likely. Of the 6 total "4 Inside 5 Setup", 5 of them went on to record a "5 Inside 6 Setup". The lone sample to finally break out of the range was September of 2000. A meaningful decline in July for the S&P 500 will certainly get my attention given the price action parallels to 2000.
July will need to trade up by 4.33% to clear February's high, and that's only occurred 13 times since 1970 (27%). Alternatively, July will need to drawdown by -6.84% to trade below February's low, and that's only occurred 5 times since 1970 (10.41%). June closed a mere 26.38 points, or 0.97%, above its monthly low, and 73.10 points, or 2.68%, below its monthly high. A July trade below June's low at 2,691.99 certainly tilts July for the worst. Since 1970, when July's low is below June's low, the month's win-loss record is 9-25 for median returns of -0.99%. July has then been a bullish outside reversal month just 5 times since 1970, so in the event the bulls don't defend 2,691.99 over the first week of July, the bears will have pushed the bulls into the corner for the month of July.
Putting it all together, there's a heck of a fight going on and the uncertainly regarding the future price action of the S&P 500 is at its highest point since the 2015-2016 period. The primary trend is up or "bullish" as of today, but there's virtually no certainty about the sustainability of our primary uptrend given how trendless the secondary trend has become. All a long-term investor can do is ensure their future actions and behavior with their investable portfolio is rules-based, clearly defined, and void of emotion, speculation, and knee-jerk reactions. Cliff Asness perhaps said it best:
"I used to think that being great at investing long-term was about genius. Don't get me wrong, genius is still good, but more and more I think it's about doing something reasonable, that makes sense, and then sticking to it like grim death through the tough times."
To be on the right side of whatever move lies ahead, you should be prepared to stick to the rules of your long-term investing plan with the discipline of 1,000 men. Like they teach us in kindergarten, when you follow the rules, you stay out of trouble.